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US Treasury, agency debt issuance to explode - UBS

NEW YORK, Feb 14 (Reuters) - Issuance of top-rated debt sold by the U.S. government and its chartered enterprises, such as Fannie Mae FNM.N and Freddie Mac FRE.N, will soar through 2009 to finance a ballooning federal deficit and the housing market, UBS Securities analysts said on Thursday.

The combination of an economic recession and the costs of President George W. Bush’s stimulus plan will probably widen the deficit by 145 percent to $400 billion in 2008 and 2009, UBS strategist William O’Donnell said on a conference call.

This will create a sea change in the supply of Treasuries just as investors appear to be chock full of the debt, he said.

“Recessions are absolutely toxic to budget deficits in the U.S.,” O’Donnell said. “Growth drives tax receipts which drive budget deficits which drive Treasury borrowing. The links in that chain are pretty tight.”

The Treasury will probably begin increasing the size of its note auctions instead of relying mostly on short-term bills, he said. It will likely reinstate issuance of one-year Treasury bills and three-year notes, which it only just eliminated from its quarterly refunding last year, he added.

Investors will also be faced with net issuance of $114 billion in debt from government-sponsored enterprises Fannie Mae, Freddie Mac and the Federal Home Loan Bank system as lenders rely on the GSEs for mortgage funding, UBS strategist Ivan Hrazdira said on the call. But the “agency” debt may outperform Treasuries given the surge in government sales.

Mortgage-backed securities issuance -- bonds that pass interest and principal from loan payments directly to the investor, but are guaranteed by the GSEs -- will also remain elevated, UBS’s Laurie Goodman said on the call.

Yields on the so-called “rates products” could jump should the increased supply coincide with an easing of the global credit crunch, the strategists said. Central banks that are major buyers of Treasury and “agency” debt are also likely to slow their accumulation of U.S. dollar reserves, reducing demand, they said.

“We expect this could be a particular problem for the Treasury market down the road, because we’re starting this trend with Treasury rates very close to historic lows in some cases,” the strategists wrote in a research note.

“When the starting gun for the rush back into credit has been fired, we believe Treasuries could suffer greatly in the mad rush for yield,” they said. (Reporting by Al Yoon; Editing by James Dalgleish)

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